Monday, November 1, 2010

Math: It's Not Important... It's Just Math Right?

Mathematics may be the most pure of the sciences. Formulas, notions, suppositions, and conclusions. It seems so abstract and not very real.

After all algebra has its letters and geometry has its points, lines, and circles. All abstract constructs. But math can be very applicable to the real world. Correct and accurate math is even more applicable.

Take the idea of insurance. I'll pick fire insurance as an example. The math is really simple. If you have 1,000 homeowners paying in to fire insurance policies then you need to make sure that you get in more than you will have to pay out. How do you determine how much you'll have to pay out? First figure out how much each fire claim will cost you. Then figure out how many claims you'll get per year for those 1,000 homeowners. Put the two together, work in some extra to run your business and some extra for profit and voila... you can run an insurance company.

Of course real life is more complicated than the simple math would indicate. The type of house, the size, the construction, the neighbourhood, the wiring, the fire alarms and smoke detectors, and any number of other variables make some houses more risky than others. As well there are average years with a certain number of claims but then there are exceptional years. Some with fewer claims and some with many more claims than is typical. You have to be able to pay up when an entire housing division goes up in smoke.

Getting the math right is crucial. Getting the complex, convoluted, and well thought out math right is even harder. If you're insurance company manages to get it right you'll end up covered during disasters instead of watching your insurance company go bankrupt and not be able to pay out claims. Catastrophes can cause problems for insurance companies and not just the immediate victims.

The Acts of God Algorithm by Art Jahnke tells the story of a new better way of looking at risk. Especially catastrophic risk. It's amazing what happens when someone looks at an old problem in a new light.

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